Thoughts From Joe - March 14, 2014

Top Eight

Crimea will vote on a secession referendum this weekend. Sunday's vote comes after a mysterious militant force took control of the region, Russia then sent troops in to protect Russian citizens there, and now a newly installed pro-Russian "prime minister" of Crimea has called for a referendum for the region to join Russia. In the meantime, the West only gestures and postures. The markets are ignoring the situation because the West is not seen as responding so a protracted conflict is not on the horizon. Russian markets are in free fall as investors move to protect assets, but Putin doesn't seem to care. Where does this end? In the short- to medium- term, only the Ukrainians and Russians will be affected, as the rest of the world is war-weary, taking an isolationist approach. Longer-term effects depend largely on Putin's next move. History has seen this before.

"the euro crisis has transformed what was meant to be a voluntary association of equal sovereign states that sacrifice part of their sovereignty for the common good" into "a relationship between creditors and debtors, where debtors have difficulty in paying and servicing their debt and that puts the creditors in charge" dividing the zone into "two classes."

This year, European banks "have an interest in passing their stress test rather than reviving credit to the economy." "They are not fulfilling their function."

"Ukraine is a wake-up call to Europe, because Russia has emerged as a rival to the European Union."

The EU is "an incomplete association of nations and it may not survive 25 years of stagnation."

"Putin has a very different idea of what society should be like. He believes that people can be manipulated." "And that's not the case, people do believe in freedom."

Puerto Rico easily sells $3.5 billion of junk rated debt. The Commonwealth raised enough cash to sustain its finances through the middle of next year as it struggles to service its $70 billion in outstanding debt. Puerto Rico enjoys "triple tax free status" in all 50 states, meaning it is mostly exempt from Federal, state, and local income taxes no matter where in the states the investor files. For this reason, its debt has been extremely attractive to investors in the municipal market, which so rarely experiences credit challenges. This perception of safety may be changing and one indication is how this new debt is structured. Specifically, it was issued under New York law per demands primarily from hedge funds. This may help fend off any suspension of payments if Puerto Rico defaults as described in this blog on Reuters.

Total global debt has increased 40 percent to top $100 trillion since the financial crisis. The Bank for International Settlements (BIS) estimates total debt has increased $30 trillion while global equities have declined by $3.9 trillion between mid-2007 and mid-2013. Wasn't the "financial crisis" a "debt crisis" and weren't we supposed to be trimming back on debt? Consumers have made some headway in pausing debt growth, but that has been more than made up by sovereigns. The U.S. accounts for about $5 trillion in overall debt growth as shown below however The Fed owns about half of that leaving a net outstanding increase of just $2.5 trillion. The point of our society's continued reliance on debt as opposed to any shift in fiscal habits remains, however.

The euro reached a two-year high this week, nearing $1.40. The currency has been heading upwards since early 2013, causing headaches at the European Central Bank (ECB), which is concerned about deflation in the region. A stronger currency decreases the cost of imports which leads to greater competition among goods providers, driving down consumer prices. Mario Draghi, head of the ECB is focused on fighting deflation, which may bring about a rate cut or, as he recently put it, "additional monetary policy changes." More global QE leading to more debt, implementing a Keynesian strategy that has yet to work anywhere in the world though it has been tried since Japan in the 1990s. Won't they learn?

Happy Birthday Internet! World Wide Web Turns 25. By 1995 as the WWW turned two years old, a Pew Research Center survey found that just 14 percent of American adults had Internet access and among them, only 2 percent had access using the fastest modem available at the time, rushing data along at a blistering speed of 28.8k. I wonder how many years went by before we stopped celebrating the birthday of the wheel?

Key Markets

U.S. equity markets fell across the board late in the week, primarily due to this weekend's vote on Crimean secession. In a reversal of "sell the rumor/buy the fact," expect the negative tone from this event to lighten in coming weeks. Russia felt the brunt with the MICEX index falling 7.6 percent on the week, or 8.2 percent after considering a weaker ruble. In addition, Japanese stocks plummeted 6.2 percent on fears of further slowdown in China.

Return
(local currency)

3/14/2014

1 Week

YTD

Treasury

3/14/2014

3/7/2014

Change

Dow

16,066

–2.4%

–3.1%

30yr

3.59%

3.72%

–0.13%

S&P 500

1,841

–2.0%

–0.4%

10yr

2.65%

2.79%

–0.14%

Nasdaq

4,245

–2.1%

1.7%

5yr

1.53%

1.64%

–0.11%

Euro Stoxx

3,0005

–2.9%

–3.4%

3yr

0.74%

0.77%

–0.03%

Nikkei

14,328

–6.2%

–12.1%

2yr

0.34%

0.37%

–0.03%

Hang Seng

21,539

–5.0%

–7.6%

1yr

0.12%

0.12%

0.00%

MSCI Emerging
Markets

943

–2.8%

–5.8%

3mo

0.05%

0.05%

0.00%

Source: Bloomberg

Looking Ahead

The Fed's FOMC meets next week and is expected to reduce QE by another $10 billion per month to $55 billion.

On the economic front, we'll get February's CPI, housing starts, and other housing data next week.

Earnings releases of note next week include:

Tuesday: Oracle, Adobe Systems, SolarCity Corp,

Thursday: TIBCO Software

Scheduled IPO issuance next week includes:

Paylocity

Q2 Holdings

Akebia Therapeutics

Amber Road

Borderfree

Versartis

A10 Networks

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Top EightCrimea will vote on a secession referendum this weekend. Sunday's vote comes after a mysterious militant force took control of the region, Russia then sent troops in to protect Russian citizens there, and now a newly installed pro-Russian "prime minister" of Crimea has called for a referendum for the region to join Russia. In the meantime, the West only gestures and postures. The markets are ignoring the situation because the West is not seen as responding so a protracted conflict is not on the horizon. Russian markets are in free fall as investors move to protect assets, but Putin doesn't seem to care. Where does this end? In the short- to medium- term, only the Ukrainians and Russians will be affected, as the rest of the world is war-weary, taking an isolationist approach. Longer-term effects depend largely on Putin's next move. History has seen this before.

George Soros predicts 25-year slump in Europe without a major structural overhaul. The billionaire investor who made his mark in the 1998 currency crisis shared many snappy quotes in this video interview with Bloomberg.

Among my favorite:"the euro crisis has transformed what was meant to be a voluntary...Read More